Before we get to the particulars of tonight’s Wall Street Journal story, we need to step back a second.

Just like the war in Iraq, which had a ton of justifications served up by the Bush Administration, none of which added up (and the most obvious one, that the Bushies wanted to control the second biggest oil reserves on the planet, somehow never gets mentioned in polite company in the US), we’ve also had too many rationales offered for the TARP in its very short life.

The one that has stuck with Congress and in the public’s mind is that it was meant to get banks lending again. And the Journal tells us that measured against that benchmark, it hasn’t worked.

Like the war in Iraq, it’s a given that the stated rationales for the TARP were not the real one. Cynics see it as a plutocratic transfer, son of the grossly inflated outsourcing contracts to Halliburton and friends in the Middle East, a last opportunistic looting of the Treasury (literally, in this case).

But this may instead have been the a recycling of Paulson’s bazooka notion. Remember when he asked for and secured authority to increase Fannie’s and Freddie’s credit lines with the Treasury and buy equity:

If you’ve got a squirt gun in your pocket, you probably will have to take it out. If you have a bazooka in your pocket and people know it, you probably won’t have to take it out.

That, as we now know, proved to be patently untrue, as the markets called the Treasury Secretary’s bluff. But Paulson is a very stubborn man and also seems to have remarkably few ideas (his initial plan for the TARP funding was a rejiggered version of his failed “rescue the SIVs” MLEC plan of the previous fall).

Recall also that Paulson is a deal guy out of Goldman. Anyone who has been in the deal business knows that the verbal representations are meaningless, and what counts is what is in the contract, or in his Treasury role, in the legislation. And Congress approved a huge blank check.

Thus I suspect the real rationale behind the TARP was that Paulson would have so much money at his disposal that he could credibly rescue the banking system, and in Bazooka version 2.0, he would not need to use it in a major way (although he would need to be perceived to have ready access to it, hence his protests over having only $350 billion for his immediate use). The existence of the funding capability would (presumably) restore confidence in the banks.

That theory would be consistent with the shifting rationales and plans. Paulson saw this as emergency authority to be used as needed and figured with that much money, he could punch above his weight (recall that $700 billion seemed simply enormous back in October, we’ve now become inured). But anyone who was up on the work from Bridgewater Associates, or connected the dots from what bank analyst Meredith Whitney was saying, or took Nouriel Roubini seriously (to name just a few) would know that $700 billion wasn’t sufficient to plug the leaks the banking system had ALREADY sprung.

But that aside, why should we expect that the TARP would lead to more lending? First, there should be less lending, independent of the economic contraction. We know now that TONS of credit was extended to people who shouldn’t have gotten it at all or should have been granted much less than they got. Those balances NEED to shrink, ideally by paying them down, although a fair bit will be via defaults and writedowns.

Second, in case you somehow missed it, the economy stinks. Even among the solvent, far fewer businesses and consumers are keen to borrow than in “normal” times. Thus, as bankers know well, those who want more credit now are likely to have a higher level of adverse selection than you’d see most of the time.

Now offsetting that to a fair degree is that a lot of businesses are dragging out payments, which puts financial stress on their vendors. They could really use more financing now, if you assume that the business itself is viable and the customers won’t default on their obligations. But banks aren’t set up to do that level of credit investigation. If you fit in the right box on their grid, great, otherwise, you are toast.

That is a long-winded way of saying it’s no surprise the banks aren’t lending. If their assets were valued realistically, most doubtless need even more equity than the TARP provided. Shrinking their balance sheets is part of their effort to get their equity back to healthy levels (memo to regulators: why isn’t there more in the way of formal regulatory forbearance right now? It’s standard bank recession practice to let banks officially run with lower equity levels as they try to get themselves back on their feet. It’s better to admit banks are undercapitalized and give them a temporary waiver than play blind with balance sheet games than undermine investor confidence).

Lending at many of the nation’s largest banks fell in recent months, even after they received $148 billion in taxpayer capital that was intended to help the economy by making loans more readily available.

Ten of the 13 big beneficiaries of the Treasury Department’s Troubled Asset Relief Program, or TARP, saw their outstanding loan balances decline by a total of about $46 billion, or 1.4%, between the third and fourth quarters of 2008…

Those 13 banks have collected the lion’s share of the roughly $200 billion the government has doled out since TARP was launched last October to stabilize financial institutions…..

The overall decline in loans on the 13 banks’ books — from about $3.36 trillion as of Sept. 30 to $3.31 trillion at year’s end — raises fresh questions about TARP’s effectiveness at coaxing banks to reopen their lending spigots.

“It has failed,” said Campbell Harvey, a finance professor at Duke University’s business school….

In a survey last month of 569 U.S. companies, Mr. Harvey and researchers at Duke and the University of Illinois found that 59% felt constrained by a lack of credit. Many of those firms are shelving expansion plans and cutting jobs as a result of funding shortages, according to the survey, which is expected to be released this week.

Yves here. Without know the size range of these companies and more about what they want to do with loan proceeds, it is hard to know what to make of that factoid. If some want to borrow to preserve payroll, they may be incurring debt to stave off inevitable firings. It isn’t clear how many of these loan requests would pass muster, independent of the financial crisis. Back to the article:

Bankers say it is unfair to expect them to funnel a large portion of their government capital into loans so soon after receiving it. They say it takes time to make prudent loans and to attract new deposits that will allow them to lend out their new capital efficiently.

Demand for low-risk loans is also ebbing as consumers and businesses rein in their spending and try to conserve cash, according to bank executives….

Despite dismal economic conditions, many bankers insist they are making every good loan that they can. Bank of America and J.P. Morgan Chase & Co., which got a combined $70 billion in government capital, said they originated a total of $215 billion in loans in the fourth quarter. Their combined loan portfolios shrank by about $28 billion in the same period.

Scott Silvestri, a Bank of America spokesman, said the Charlotte, N.C., bank’s loan balances declined in part because more borrowers have been paying off their debts. In addition, “there were fewer opportunities to make high-quality loans because of the recession.”

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28 comments

Of course the US has switched rapidly to being net savers (except the government, of course).

The party is ending badly, and it is absurd to expect it to continue anyway.

As you lay out beautifully… If you have the money you are hoarding it. If you have debt you are either trying to pay it off or hang on by your fingernails. We all have friends and jobs and businesses. We know first hand that it is happening.

Your numbers and charts (loan portfolios shrank by 28B) and lending rates are down by a few percent seem light to me, but that probably includes a lot of rolling credit that was already in the pipeline.

Good writeup. There’s another aspect to the problem: banks are delevering from asset books that required less regulatory capital per dollar loaned than does holding the credits on-book. Once you remove credit-enhanced securitization, SIV hocus-pocus, etc., you need several times as much regulatory capital to originate and hold loans — this is wholly apart from the issue of capital needed to absorb losses already in the books. Even if Citi’s losses were entirely covered, even if every new loan met traditional underwriting standards, Citi would still require massive new capital to hold credits that used to get flushed into secondary markets.

One under-appreciated difference between this banking crisis and the last one is the advent–and demise–of originate to distribute (and capital regs that blessed worthless credit enhancements). That’s dead now, and bank balance sheets can’t supply equivalent loan volumes. So far, DC’s response has been to stuff as much as possible to the new monopoly buyer of asset-backed paper — the Fed — in order to keep the systemic leverage up. If banks couldn’t offload new and rolling credits to the Fed, the system would seize. But how much longer can that go on?

Yves, that IMF comparative study of banking crises found that regulatory forbearance was associated with a worse outcome.

As you point out, whether a loan should be made depends on the creditworthiness of the borrower. It’s quite possible for lending to be looser in that a borrower of a set risk can get a cheaper loan while net lending is down because creditworthiness declines faster. To see what’s really going on, we need bank lending measures broken down by creditworthiness, somewhat like how we measure AA, A2/P2, and junk paper.

Obviously we need to return to good lending practices after the previous binge. Since we had so much garbage lending over the past few years, any return to more sensible standards will reduce lending. So if lending is down, that’s not really a problem; that’s what *should* be happening. We need very precise measures (like the idea of risk-adjusted measurements) to determine whether the reductions are excessive, appropriate, or inadequate.

Your point on regulatory forbearance well taken, but I probably should have made my point clearer.

We have backhanded regulatory forbearance as it is via phony accounting (Steve’s SIV example plus Level 3 assets) with the result that no one trusts bank balance sheets, nor do they trust bond ratings.

It would be better to clean up the accounting and have formal forbearance. That would be the lesser of two evils. We’d at least have a better idea of where we stood and some brave investors might start selectively bottom fishing. But if you assume that that approach would reveal that most banks have zero or negative equity, no amount of old fashioned forbearance will suffice.

I have seen posted here or in one of the other blogs I read recently that the banks are still lending plenty of money on balance sheet but the securitization market and off balance sheet lending (shadow banking) has been destroyed, which is where the real problem is. The journal article seems to contradict the “banks still lending plenty” hypothesis and annoyed me enough to actually do some cursory research. The St Louis Fed keeps stats on the total credit in commercial banks:

If you look at the recent data, you’ll see total credit didn’t actually contract AT ALL until the week of 10-29-2008. If you look at commercial and industrial loans those show a similar pattern with the week of 10-22-2008 being the high water mark. http://research.stlouisfed.org/fred2/series/CIBOARD

After looking at the data, it seems to me that the Journal article does appear to be correct in that loans and credit are decreasing, but only since the end of October for on balance sheet items. Does anyone here know of data that shows any approximations of the contraction of lending in off-balance sheet vehicles? Also, could the recent on-balance sheet contraction show that banks have now completely contracted credit off balance sheet and now the problem is bleeding into the on-balance sheet loans? Are there good stats on CDO origination anywhere?

It is asinine from where I stand to expect banks to even extend credit at the high water mark level when securitization is supposedly dead, not even mentioning increasing the RATE of credit growth which is what fueled the boom. How can anyone in Washington talk about “getting banks lending again” as a solution to the crisis given the data above? (Hopefully this post isn’t too scatterbrained for a response)

The obvious fact is that they are insolvent which is why they should be audited and the insolvent taken out.

The insolvent banks are costing us way more than $350 billion. It is their insolvency that has the Fed in all sorts of markets underwriting business that won’t be done because of mistrust in the system. The Fed’s interventions and purchase of assets for and from these insolvent banks is in the trillions of dollars.

We need to nationalize the banks and scrub the books.

We need to fire the privately owned and operated Federal Reserve and install a Public Central Bank. Why? Because the Federal Reserve knew these banks were insolvent yet chose to underwrite their books and all the markets these banks tainted instead of declaring them insolvent and cleaning up the mess. But the Fed was only acting on its’ mandate, that is, working to the benefit of its’ shareholders, the Member Banks that were insolvent in the first place. Time to fire the Fed and install a Public Central Bank. Canada did in 1936!

Just taking a look at its board members tells me there is more than a better chance that musical chair valuations could be happening there.

Company Overview

The Clearing House (TCH) is a banking association that offers deposit banking functions and payment services. The Clearing House manages and operates the Clearing House Interbank Payments System (CHIPS), the National Check Exchange, the Electronic Payments Network (EPN), and Electronic Clearing Services (ECS). It is owned by the U.S. commercial banking affiliates of ABN AMRO, Bank of America, The Bank of New York, Bank One, Citigroup, Deutsche Bank, Fleet National Bank, HSBC, JP Morgan Chase Bank, Wachovia, and Wells Fargo.

I agree that we should not expect lending to increase and it is mostly the uncreditworthy that are now desperate for loans. For me, one of the key statements you made though was:

But banks aren’t set up to do that level of credit investigation. If you fit in the right box on their grid, great, otherwise, you are toast.

This is where the catastrophe is happening. If you have two builders in a town and one goes bust, then there is a reasonable chance that the other builder might pick up some business. The bank however will view all builders in the same light and is no longer capable of proper credit investigation. Banks ought to be rapidly increasing their work force, preferable with people who have local knowledge who can make a proper credit judgement and unfortunately that ought to be priced into the cost of the loans.

The current problem is that banks seem unable to provide credit to the survivors of decimated sectors with the result that whole sectors of business are being wiped out. This contrasts quite markedly with the rest of the worlds banks who are cutting centralised banking staff and increasing local staff.

Nice point about “regulatory forbearance” between Yves and “Faireconomist.”

Regulatory forebearance may be a good idea…but I can remember when the government used to try and run surpluses every now and than to balance the deficeits. Now, just deficeits. I fear the same with regulatory forbearance…how long would it last…a year? 2? 5?

This is why the thievery ran unabated after the dot.boom bubble broke. Natural any settlement will also include something about without admitting wrong doing. The management here needs to be in prison. A monetary settlement to these guy means nothing but a get out of jail free card and in this case with OPM.

This post sounds like an excuse for the banks not lending more, given they received TARP funds. How exactly is lending less standard practice in lean times? It could be true, given historical precedent, but these are not ordinary lean times. True, the world economy is in the worst shape in decades; but then again they have received a lot of extra funding in the form of TARP bailouts. At the very least, lending should continue, but risk management needs to top the agenda. Manage the risk, don’t act like a fool, and lend to people who can repay. It’s pretty simple. But I do agree with you that that Paulson is nothing more than a stupid dealmaker.

The big banks are not lending, and will continue to suck up every drop of credit offered by the fed/gov’t, because they’re afraid that their paper insolvency leaves them vulnerable to the kind of confidence crisis that killed Bear and Lehman and Wachovia.

They are insolvent in the sense that their assets have declined so dramatically as to leave liabilities overweight.

The assets have declined largely due to a confidence problem about the methodologies used to create and forecast performance of structured finance instruments like mortgage bonds and CDOs.

The most responsible thing the gov’t can do to cure the insolvency crisis is replace current accounting with a price control regime that would allow the banks to mark their wounded assets in accord with performance instead of (non existent) market value.

Bill Seidman this week said that They can’t price the wounded MBS etc, and that therefore a reversion to the original TARP idea (buy the assets from the banks, ala mode Seidman’s old RTC) won’t work.

BUT further comments showed that what he meant is NOT that a “hold-to-maturity price” (Bernanke’s term) is unfathomable, but, rather, that in October the banks and the feds couldn’t agree on a price.

That is:

— Tsy didn’t want to pay best guess hold-to-maturity because that would be assuming all risk and paying all/most value to the miscreant banks.

— And the banks weren’t willing to take anything in the neighborhood of (non-existent) market value.

Ie, the problem is NOT that a performance-based price cannot be decently estimated. It’s that nobody wants to TRANSACT today (and this past October) at those prices.

THUS a fortiori: Instead of BUYING the wounded assets, the feds should prescribe controlled prices for them (segmented demographically across the wounded sectors of the structured finance universe).

These controlled prices would be based on short-term trailing performance — how much interest is actually being paid and how much principal actually being lost — and best guesses re the housing industry for coming six months or so. Prices would then be adjusted quarter by quarter.

The banks would get immediate write-ups to something near best guess hold-to-maturity price, while retaining risk going forward.

The feds would have to do a ton of spreadsheeting and regulating, but would not have to lay out the several trillions more that Paul Volcker spoke of this week while introducing Tim Geithner.

The market for mortgage bonds and related has been broken for 18 months, and the markets for other structured-finance things like credit card bonds not much better. Broken markets do not always fix themselves. These are not. Time to open the toolbox.

Price controls WERE in the toolbox during the postwar era (Eisenhower, Kennedy, Nixon) — until the owner-operator class realized in the 80s that globalization was the ticket and got laissez-faire religion.

People who spent their formative years watching Age of Reagan television have driven the global economy into the ground. It’s time to bench them, and open the toolbox.

Yves, I agree transparent forbearance would be better than the current opaque forbearance, or perhaps more properly “psychotic denial”. But don’t you think any honest accounting would show the banks to be at the very least hopelessly undercapitalized? At this points just about anybody’s estimates for losses at least match the capitalization of the financial sector. Amongst the few who seemed to have some idea of what was coming (e.g. Roubini) the estimates far exceed the capitalization of the financial sector. Masses of banks with negative equity is pretty much a given at this point.

The entire destruction of the private sector was well thought out in advance. It was a gambit and the results are continuing to unfold. In fact, the gambit (opening moves) have not yet been completed, although we are nearing the ‘mid game’ of bank nationalization, US dollar firmly ensconced as THE world reserve currency, Britain thrown under the train, along with Iceland, some Western European countries, maybe Greece,et al…oh well, remember, these guys are Ruthless.

Key is the fact that the US Gov had to do something to arrest the rapid rise in consumer debt to GDP ratio vs Gov debt to GDP ratio. Consumer debt, which had climbed much faster than Gov debt, had to be reduced/slowed without a general uprising of the populace. No torches and pitchforks. The entire game was well thought out to make it look like ‘the gov was trying to make housing affordable for all and we made a mistake…we didn’t know that home prices would climb and people would walk away from them and consumer and business credit and banking would be squashed…honest.’

At the same time our traditional rivals, China, Russia, Venezuela, et al, needed a blow to their economies to reduce them as threats to US dominance and the dominance of the dollar as world reserve currency. Manipulation of commodity markets is easy if one can manipulate the oil market. All other commodities require oil to produce, extract, transport, etc. So, the oil market was driven up using Philbro and other off shore operations, other commodities had to follow. Oil producing countries had begun spending their new found wealth on new programs untill oil crashed, then leadership and economies in those countries came under scrutiny and pressure.

China was easy. They import all commodities in large quantities, except coal which they produce a lot of. China is dependent on the world to purchase it’s value added goods. China got a double dose…whipsaw in commodities plus a loss of customers for their production.

A run up and subsequent crash in housing prices is the price that Americans will pay plus what money they have will buy less in the future, and they will not be good credit risks so they wont have much access to credit. Money was kept artifically cheap for this gambit to work. The intense mortgage operation in residential and CRE had to be completed quickly before mortgages began blowing up. That the blow up would happen in mortgages was a no brainer even though many lied, or were really stupid, and say they didn’t see it coming.

Blow up time in mortgages and an almost instant shut down of consumer spending in US! China hangs up the ‘out to lunch’ sign. Russia and the oil producers cut back on their new programs, including rearmaments.

End game? It looks like a nationalization of banks and a command economy coming…but, this could be a ruse. It could happen that banks will be nationalized for a time followed by slow recapitalization followed by reprivitization. The government now has all the power and I see no way that conumers can over spend in the future. The consumer debt to GDP ratio will continue to fall untill it resembles the former USSR…ZERO consumer credit. Maybe we are headed for a total command economy?

Maybe you can fill in the blanks for the end game?

One more thing, had we really been thinking when Cheney famously said ‘The American way of life will not be compromised’ we might have made sense of this gambit much sooner.

If you were a bank, would you provide floor plan financing to auto dealers today? What about overleveraged retailers? What about consutruction loans to homebuilders or commercial builders? What about loans to consumers that have significant amounts of debt already and have experienced job losses or reductions of value of 15-50% of their principal asset – their homes? Too much debt was a major cause of the problem and heaping more debt on borrowers is not a sane solution. Insolvent borrowers being encouraged to make loan to insolvent borrowers – just as crazy as Chrysler pushing dealers to buy mor einventory.

There is a consensus among these works, however, that Roubini predicted the French Revolution, Napoleon Bonaparte, Adolf Hitler, both world wars, and the nuclear destruction of Hiroshima and Nagasaki. There is also a consensus that he predicted whatever major event had just happened at the time of each book’s publication, from the Apollo moon landings, through the death of Diana, Princess of Wales in 1997, and the Space Shuttle Challenger disaster in 1986, to the events of 9/11 and John Thain’s failed remodeling project @ BAC: this ‘movable feast’ aspect appears to be characteristic of the genre

River said… Yves, here is the game as I see it.__________________________________The NEw World order…

of course this is rumor and innuendo, but it was widely reported. Also reported that Obama stopped by the pow wow in Virginia.

“The ultra-secretive Bilderberg Group, a consortium of power brokers from banking, business, politics, academia and oil, met in Munich Germany in May 2005 when crude oil prices were around the $40 a barrel mark.

During the conference, Henry Kissinger told his fellow attendees that the elite had resolved to ensure that oil prices would double over the course of the next 12-24 months, which is exactly what has happened”

I too have devised (and patented) a complex algorithm by which I can predict any — I repeat, ANY — past event by simply counting the number of vowels along the diagonal of every odd page of the Seattle phone book, and dividing it my date of birth. I then do a Google search, and bingo! I get the answer.

I too am a member of the ultra secretive Bilderberg Group. But I feel we are greatly misunderstood. We really aren't interested in running the world, nor do we care about enriching ourselves at the expense of the lazy masses on welfare. We simply are a bunch of party animals interested in drugging, boozing, and wroreing. Our meetings are little more than orgies.

I am sure if you would have seen Dick Cheney (or "Vice" as he is known to us) unleash himself and jar of Viagra on a group of young — very young — Eastern European males you would feel so much better about us. We really are just like YOU…

God bless you and best of luck with all that stuff; I really miss you and wish we could have become friends or maybe at some point, just sat down and got to know each other, but no. The best we can hope for is to make sense of these black symbols on a glowing desktop monitor. Where will the pain stop?